Teach your children (to save) well

Children need to learn early how to save for their whole life

By

JohnPelletier

Our children’s future happiness depends on how carefully they think and plan for the future, particularly when it comes to saving for college, a rainy day or retirement. They need to learn to develop their saving muscle memory—their ability to save early and often—for their entire adult lives.

Just like going to the gym regularly to work our body’s muscles, young people must develop saving muscles because their retirement security depends on it. Here are some “exercises” I heartily endorse:

Get in the habit of saving: Many of us develop bad habits, saving is a great one. Saving is like a muscle—if you don’t use it, it shrivels up and atrophies. The first step is deciding to do it. Too many people think they can’t save money, but you need to treat savings like food, clothing, shelter and transportation. It is a necessity. So look at your nonessential purchases—junk food or going to the movies—as decisions not to save. Each time you elect to buy something you don’t need, you are not saving for something you do need—a car, a home, a college fund or retirement.

Have a bucket list: Children should divide their earnings, gifts and allowances into three equal buckets—spending money on those nonessentials, short-term savings for items like a new cellphone or video game, and long-term savings for expensive items that may take years to save for, like a video game console, a computer, a car or college.

This discipline creates saving muscle memory and helps young people as adults prepare for a rainy day and retirement.

The Bank of Mom and Dad: Since the Great Recession, the Federal Reserve Board has made teaching the power of savings to our children virtually impossible. Today, a one-year Certificate of Deposit or CD pays about 0.5% annual interest, which inflation, at around 2% a year, more than negates. So let’s forget the Fed. You, mom and dad, can be the bank. Have your children hand over their savings to you and you pay them 5% interest. Thus, on $100 saved annually, you’re paying $5 in interest vs. 50 cents at the local bank.

Teach them about compound interest: As you calculate your children’s interest, make sure they understand that the $5 in interest they earn in a year will also earn interest, and that is how money grows. Tell them the story, which is probably urban legend but valuable nonetheless, about how Albert Einstein once called compound interest the greatest invention in human history. It’s a tough lesson to teach in this era of low interest rates, but it’s worth showing children how it is possible for money to grow dramatically over time.

For example, $100 will double in 140 years at the current 0.5%interest rate, but at 5%, it only takes 14 years. At a 7% interest rate, your money doubles in a decade.

Americans are notorious spendthrifts, so these lessons may be challenging to teach your kids. Start by telling them the truth—that Americans have not saved enough, and part of our financial difficulties are undoubtedly rooted in this lack of saving muscle memory.

From 1960 to 1980, Americans routinely saved 10% or more of their disposable household income. That rate plunged from about 8.5% in 1985 to 1.5% in 2005. Currently, the savings rate has rebounded to about 4.5%. Americans have not always failed to save for the future and been addicted to debt. You need only go back to the early 1980s to see a nation of savers who tried to live within their means.

And while you’re teaching your children about saving, let your local schools know it’s their responsibility to teach personal finance as well. Our center did a study this summer to gauge how well, or not, high schools around the nation embraced the subject. You can read how each state fared here.

The following facts show why it is so important to make sure our children develop savings muscle memory:

A recent Finra Investor Education Foundation survey indicates that 55% of American adults are not saving and 56% don't have a rainy-day fund, defined as money set aside to cover three months of essential expenses.

The average retired individual receives about $15,000 a year in Social Security benefits. For nearly two-thirds of elderly beneficiaries, Social Security provides the majority of their cash income. For more than one-third, it provides more than 90% of their income.

And for one-quarter of elderly beneficiaries, Social Security is the sole source of retirement income.

According to the Employee Benefit Research Institute, more than half of workers nationally report they and/or their spouse have less than $25,000 in total savings and investments (excluding their home and defined benefit plans), including 28% who have less than $1,000.

Parents, you must teach your children how to save. Depending on your situation, you may have to add, “do as I say, not as I do.” But the savings lesson must be taught.

John Pelletier is director of the Center for Financial Literacy at Champlain College and formerly chief operating officer of Natixis Global Associates and chief legal officer of Eaton Vance Corp. Follow John on Twitter.

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